Most U.S. Cities and States Float in a Sea of Red Ink

Nearly every state in the Union and nearly every large city are facing ballooning budgets and shrinking tax revenue (confiscation). Some, such as Illinois and California, are boarding on insolvency and need to fill budget holes that are tens of billions of dollars. Tax receipts everywhere are plummeting because of the high unemployment rate that, in reality, is above 22%. On top of that, foreclosures hit another record nationwide in 2010 and are expected to set yet another one this year.

Those empty homes are shrinking property tax receipts and are another blow to budgets across the country. States and cities cannot print money, so cuts are being made to make up for the shortfalls. Public pensions alone are $2.5 trillion in the red. There’s talk of passing Federal legislation that will allow individual states to go bankrupt as a way to slash pension obligations. Cites are cutting workers and laying off firefighters and police. Things have gotten so bad in Camden, New Jersey, that it fired half its police force this week. Camden is the second most dangerous city in America and is probably on its way to number one.

Illinois is going the other way. Last week, the state legislature passed a bill that would raise personal income taxes by 67% and corporate taxes by 46%. Bordering states can’t wait for the new businesses and taxpayers fleeing the land of Lincoln. How can we be in an economic recovery when cities and states are fighting to stay afloat?

The one thing you can’t count on is a bailout from the Federal Reserve. Never mind the Fed spent a staggering $12.3 trillion to bail out foreign and domestic banks, private individuals, hedge funds, and corporations like Toyota and Harley-Davidson. When it comes to the guy on main street, the Fed said kiss-off.

Last week, Ellen Brown wrote an excellent article on the Fed’s recent decision NOT to help the common man. Ellen and I disagree on the inflationary effect of the Fed’s actions, but her sourcing and journalism are excellent. Please take the time to read her first-class work below.—Greg Hunter–

The Federal Reserve was set up by bankers for bankers, and it has served them well. Out of the blue, it came up with $12.3 trillion in nearly interest-free credit to bail the banks out of a credit crunch they created. That same credit crisis has plunged state and local governments into insolvency, but the Fed has now delivered its ultimatum: there will be no “quantitative easing” for municipal governments.

On January 7, according to the Wall Street Journal, Federal Reserve Chairman Ben Bernanke announced that the Fed had ruled out a central bank bailout of state and local governments. “We have no expectation or intention to get involved in state and local finance,” he said in testimony before the Senate Budget Committee. The states “should not expect loans from the Fed.”

So much for the proposal of President Barack Obama, reported in Reuters a year ago, to have the Fed buy municipal bonds to cut the heavy borrowing costs of cash-strapped cities and states.

The credit woes of state and municipal governments are a direct result of Wall Street’s malfeasance. Their borrowing costs first shot up in 2008, when the “monoline” bond insurers lost their own credit ratings after gambling in derivatives. The Fed’s low-interest facilities could have been used to restore local government credit, just as it was used to restore the credit of the banks. But Chairman Bernanke has now vetoed that plan.

Why? It can hardly be argued that the Fed doesn’t have the money. The collective budget deficit of the states for 2011 is projected at $140 billion, a mere drop in the bucket compared to the sums the Fed managed to come up with to bail out the banks. According to data recently released, the central bank provided roughly $3.3 trillion in liquidity and $9 trillion in short-term loans and other financial arrangements to banks, multinational corporations, and foreign financial institutions following the credit crisis of 2008.

The argument may be that continuing the Fed’s controversial “quantitative easing” program (easing credit conditions by creating money with accounting entries) will drive the economy into hyperinflation. But creating $12.3 trillion for the banks — nearly one hundred times the sum needed by state governments — did not have that dire effect. Rather, the money supply is shrinking – by some estimates, at the fastest rate since the Great Depression. Creating another $140 billion would hardly affect the money supply at all.

Why didn’t the $12.3 trillion drive the economy into hyperinflation? Because, contrary to popular belief, when the Fed engages in “quantitative easing,” it is not simply printing money and giving it away. It is merely extending CREDIT, creating an overdraft on the account of the borrower to be paid back in due course. The Fed is simply replacing expensive credit from private banks (which also create the loan money on their books) with cheap credit from the central bank.

So why isn’t the Fed open to advancing this cheap credit to the states? According to Mr. Bernanke, its hands are tied. He says the Fed is limited by statute to buying municipal government debt with maturities of six months or less that is directly backed by tax or other assured revenue, a form of debt that makes up less than 2% of the overall muni market. Congress imposed that restriction, and only Congress can change it.

That may sound like he is passing the buck, but he is probably right. Bailing out state and local governments IS outside the Fed’s mandate. The Federal Reserve Act was drafted by bankers to create a banker’s bank that would serve their interests. No others need apply. The Federal Reserve is the bankers’ own private club, and its legal structure keeps all non-members out.

Earlier Central Bank Ventures into Commercial Lending

That is how the Fed is structured today, but it hasn’t always been that way. In 1934, Section 13(b) was added to the Federal Reserve Act, authorizing the Fed to “make credit available for the purpose of supplying working capital to established industrial and commercial businesses.” This long-forgotten section was implemented and remained in effect for 24 years. In a 2002 article called “Lender of More Than Last Resort” posted on the Minneapolis Fed’s website, David Fettig summarized its provisions as follows:

– [Federal] Reserve banks could make loans to any established businesses, including businesses begun that year (a change from earlier legislation that limited funds to more established enterprises).

– Reserve banks were permitted to participate [share in loans] with lending institutions, but only if the latter assumed 20 percent of the risk.

– No limitation was placed on the amount of a single loan.

– A Reserve bank could make a direct loan only to a business in its district.

Today, that venture into commercial banking sounds like a radical departure from the Fed’s given role; but at the time it evidently seemed like a reasonable alternative. Fettig notes that “the Fed was still less than 20 years old and many likely remembered the arguments put forth during the System’s founding, when some advocated that the discount window should be open to all comers, not just member banks.” In Australia and other countries, the central bank was then assuming commercial as well as central bank functions.

Section 13(b) was repealed in 1958, but one state has kept its memory alive. In North Dakota, the publicly owned Bank of North Dakota (BND) acts as a “mini-Fed” for the state. Like the Federal Reserve of the 1930s and 1940s, the BND makes loans to local businesses and participates in loans made by local banks.

The BND has helped North Dakota escape the credit crisis. In 2009, when other states were teetering on bankruptcy, North Dakota sported the largest surplus it had ever had. Other states, prompted by their own budget crises to explore alternatives, are now looking to North Dakota for inspiration.

The “Unusual and Exigent Circumstances” Exception

Although Section 13(b) was repealed, the Federal Reserve Act retained enough vestiges of it in 2008 to allow the Fed to intervene to save a variety of non-bank entities from bankruptcy. The problem was that the tool was applied selectively. The recipients were major corporate players, not local businesses or local governments. Fettig writes:

Section 13(b) may be a memory, . . . but Section 13 paragraph 3 . . . is alive and well in the Federal Reserve Act. . . . [T]his amendment allows, “in unusual and exigent circumstances,” a Reserve bank to advance credit to individuals, partnerships and corporations that are not depository institutions.

In 2008, the Fed bailed out investment company Bear Stearns and insurer AIG, neither of which was a bank. John Nichols reports in The Nationthat Bear Stearns got almost $1 trillion in short-term loans, with interest rates as low as 0.5%. The Fed also made loans to other corporations, including GE, McDonald’s, and Verizon.

In 2010, Section 13(3) was modified by the Dodd-Frank bill, which replaced the phrase “individuals, partnerships and corporations” with the vaguer phrase “any program or facility with broad-based eligibility.” As explained in the notes to the bill:

Only Broad-Based Facilities Permitted. Section 13(3) is modified to remove the authority to extend credit to specific individuals, partnerships and corporations. Instead, the Board may authorize credit under section 13(3) only under a program or facility with “broad-based eligibility.”

What programs have “broad-based eligibility” isn’t clear from a reading of the Section, but long-term municipal bonds are evidently excluded. Mr. Bernanke said that if municipal defaults became a problem, it would be in Congress’ hands, not his.

Congress could change the law, just as it did in 1934, 1958, and 2010. It could change the law to allow the Fed to help Main Street just as it helped Wall Street. But as Senator Dick Durbin blurted out on a radio program in April 2009, Congress is owned by the banks. Changes in the law today are more likely to go the other way. Mike Whitney, writing in December 2010, noted:

So far, not one CEO or CFO of a major investment bank or financial institution has been charged, arrested, prosecuted, or convicted in what amounts to the largest incident of securities fraud in history. In the much-smaller Savings and Loan investigation, more than 1,000 people were charged and convicted. . . . [T]he system is broken and the old rules no longer apply.

The old rules no longer apply because they have been changed to suit the moneyed interests that hold Congress and the Fed captive. The law has been changed not only to keep the guilty out of jail but to preserve their exorbitant profits and bonuses at the expense of their victims.

To do this, the Federal Reserve had to take “extraordinary measures.” They were extraordinary but not illegal, because the Fed’s congressional mandate made them legal. Nobody’s permission even had to be sought. Section 13(3) of the Federal Reserve Act allows it to do what it needs to do in “unusual and exigent circumstances” to save its constituents.

If you’re a bank, it seems, anything goes. If you’re not a bank, you’re on your own.

So Who Will Save the States?

Highlighting the immediacy of the local government budget crisis, The Wall Street Journalquoted Meredith Whitney, a banking analyst who recently turned to analyzing state and local finances. She said on a recent broadcast of CBS’s “60 Minutes” that the U.S. could see “50 to 100 sizable defaults” in 2011 among its local governments, amounting to “hundreds of billions of dollars.”

If the Fed could so easily come up with 12.3 trillion dollars to save the banks, why can’t it find a few hundred billion under the mattress to save the states? Obviously it could, if Congress were inclined to put non-bank lending back into the Fed’s job description. Then why isn’t that being done?

The cynical view is that the states are purposely being kept on the edge of bankruptcy, because the banks that hold Congress hostage want the interest income and the control.

Whatever the reason, Congress is standing down while the nation is sinking. Congress must summon the courage to take needed action; and that action is not to impose “austerity” by cutting services, at a time when an already-squeezed populace most needs them. Rather, it is to create the jobs that will generate real productivity. To do this, Congress would not even have to go through the Federal Reserve. It could issue its own debt-free money and spend it on repairing and modernizing our decaying infrastructure, among other needed works. Congress’ task will become easier if the people stand with them in demanding action, but Congress is now so gridlocked that change may still be long in coming.

In the meantime, the states could take matters in their own hands and set up their own state-owned banks, on the model of the Bank of North Dakota. They could then have their own very-low-interest credit lines, just as the Wall Street banks do. Rather than spending or selling off valuable public assets, or hoarding them in massive rainy day funds made necessary by the lack of ready credit, states could LEVERAGE their assets into a very strong and abundant local credit system, following the accepted business practices of the Wall Street banks themselves.

———————————————————————-

The Public Banking Institute is being launched on January 13 to explore that alternative. For more information, see http://PublicBankingInstitute.org.

About the Author

Greg Hunter

Greg is the producer and creator of USAWatchdog.com. The site’s slogan is “analyzing the news to give you a clear picture of what’s really going on.” The site will keep an eye on the government, your financial interests and cut through the media spin. USAWatchdog.com is neither Democrat nor Republican, Liberal or Conservative. Before creating and producing the site, Greg spent nearly 9 years as a network and investigative correspondent. He worked for ABC News and Good Morning America for nearly 6 years. Most recently, Greg worked for CNN for shows such as Paula Zahn Now, American Morning and various CNN business shows.

Comments

iknowbetter01/19/2011 •

This article seems to hit all the right points. However, the author errs in stating that “…when the Fed engages in “quantitative easing,” it is not simply printing money and giving it away. It is merely extending CREDIT…”

Sounds good, until you understand that CREDIT is the same as money and the creation thereof… just like Fractional Reserve Banking where a person deposits $1000 and the bank uses it to create $10,000 in loans. The bank may not be giving money away, but they do help create it. And for every CREDIT there is a DEBIT.

Not convinced? Pull a greenback out of your wallet. It says “Federal Reserve Note.” Ponder for a moment what a “note” is.

A “note” is a promise to pay. A “note” underlies your home mortgage (if the buggers can find it).. A “note” is an official IOU. A debt to be paid. Your “money” is a “note.”

So, when we spend greenbacks (dollars) we are merely trading microbonds. Dollars seem like money, but they are really phantoms of credit and debt creation… credit being the operative word.

People have to wake up. Whatever the FED does, it is either creating money or destroying it. Full Faith and Credit in the currency is being weakened. Protect yourselves.

Iknowbetter,
Yes I agree. That is the one point I disagree with her on, but the rest of her work is first-class. That is why Is put her on the site. You make an excellent point here with the “note.”. Thank you.
Greg

Greg, good article. I don’t want the cities and states to get bailed out, they need to do what my family has had to do during this downturn, cut spending everywhere – same goes for the American government. In California there is a fee for everything and our esteemed cities, counties, as well as the state are up at night trying to add and find where they can place another fee for everything from your kids selling lemonaid in the front yard to charging you to for filing a police report if you are involved in a fender bender – it goes on and on. Recently my county raised the sells tax up again, it is now just under 10%. Taxes, fees, permits, licenses, reports, fines & just about every thing you can imagine to use or or service is subject to their grabby gloves. It is sinking the ship. The big shots run around in state, county and city vehicles with high salaries and big pensions with full retirement of 95% of salary at 55 years of age. The local governments employees salaries are very high for the times. This is why you don’t hear anything from them, they don’t want any change as they know they are a big cog in this wheel having helped get us here; but they don’t want to be any part of the solution by having any cuts.

The middle class is now going underground with respest to all the fees, permits, and other cost placed upon them. It not that they are not law abiding its just that they cannot suvive paying for it any longer. It cost so much to take a load of trash to the dumb nowadays that you see it being dumped just outside the cities at night. Insurance for many vehicles are purchased in order to register them with the department of motor vehicles then cancelled hoping not to get stopped during that year. There is talk about a bicycle license now which cost 12 years and older a yearly permit fee. Can you believe bicycles with licensed plates, with yearly plates? The waiting line to go to the Department of Motor Vehicles without an appointment is 4 hours; it takes weeks to get an appointment. Any wonder why the this state is running off its citizens, the employed or not. Simply stated, if you don’t have big bucks, a big job with a city or state, you have moving on your mind.

Businesses are leaving to Nevada where there is no state income tax, its 9% here for the average Joe. 30% for Fed tax, 9% for State, 10% sales tax to purchase what’s left, fees, permits, fines on top of all that; doesn’t leave a lot for utilities & food. 30 percent of all food items are now deemed snack foods now and subject to sales tax and the list is growing.

Greg, the great society is not so great out here any longer. I never use to see rich people as there were so much middle class that it didn’t matter. Now they stand out in the crowd because there are very little middle class left. This state has been taken over by the wealthy, the state & county employees unions control state congress, and the little people, the “new” working poor be dammed. On the backs of the people will they ride till the horse cannot stand. This state is not a pretty site. Yes, the big companies are here, e-bay and the like, giant software companies, fortune 500 and the like, but most of us are citizens as usual who were satisfy with a small piece of the American dream which has now be eliminated.

I could go on but you get the picture and all the state is worried about is balancing the budget at the cost of the middle class. The police department of my little town of 8,000 now has its own helicopter. The nearest town, population of 80,000 15 miles away, has a full time police liaison position at $100k a year salary plus benefits; including vehicle to use to take home. By the way, in my small community there are police cameras abound on the streets.
Bailout or loans to municipalities? No Greg, that would be ill advised like giving candy to a diabetic, not a good cure. They must cut out the sugar like the middle class has had to do here in la la
land.

I am one who does not know what will happen. Here in Franklin County, VA my mothers lake front house is still being taxed at 2008 prices. The county will do reapprasials this year for next years tax. I just don’t see how our county can take a 30-40 % hit intax collections. The Virginia state law requires the real estate property tax apprasials be at “market value” That is not the case now where real estate taz appraisals never fell in mass across the board reflecting the crash in real estate prices.

Greg,Yesterday They Swore in The Governor, here In Texas. Later in the the Day, came grim budget report. A 31 Billion(Projected) shortfall in Revenue, for next Two operating Years. Billions must be cut from State Education and Medicaid Programs. Two Thousand State Employees , may lose their Jobs. It does not take Einstein, to figure the numbers(Jobs) that could be lost in Public Education and Health Care. Source. Houston Chronicle.

NM,
Bernanke did not wipe out all the banks debt but a good chunk of it. The powers got the Financial Accounting Standards Board (FASB) to change the rules. The rule change allowed the banks to value sour and devalued assets on their books (real estate and mortgage-backed securities) at fantasy values. If the rule was changed back to the way it was before most banks would be insolvent. That’s why I think all bank earnings are highly suspect. Your comment : “. . .who are the banks going to do business with? Aliens from outer space?” is well stated. Thank you for passion and comment.
Greg

Greg,
Another great thought provocative article. There are so many misleading communications thrown at us daily that reading you is peaceful to my soundness. Thanks !! One question. I have noticed in the right margin of your web page that companies where I have made internet purchases are putting pictures of items that i have recently purchased there and requesting me to purchase more. How do they know it is me ? Kinda spooky to a country boy.

Every time I hear these politicans and other public officials crying about money woes I often wonder if we’re getting the whole story on the true fin’l condition of the city, county, etc.

Turns out there may be more to this story that meets the eye because we always hear them talk about their budgets and projected revenues at the BEGINNING of the fiscal year but how many times do we hear about the actual results (including income from investments & other revenue generating operations )at the END of the year?…..like maybe never?

Actually, there’s a report that covers this info called a CAFR (Comprehensive Annual Fin’l Report) and it must be filed by every public entity like schools, cities, counties, etc. According to some researchers the public knows very little about the huge surpluses of $ being used to invest in various well known corporations by gov’t entities and it’s not clear if profits from such actions are included in the general revenues to help offset potential increases in local taxes.

Also known as ‘rainy day funds’ these pools of $ could be available to help offset major fin’l problems but usually are not utilized. One glaring example was the Orange County debacle a few years ago that centered around a billion or so in derivatives gone bad while at the same time they had several billion available in these CAFR funds to ease the pain.

With the looming problems being faced across the country it’s high time that all the cards are placed on the table and let’s see the TRUE condition of the entities represented by these folks whining about their finances….after all they wouldn’t ever lie to us would they?

You can’t get blood from a stone but our government is certainly trying to accomplish just that. With the endless list of taxes we pay on a daily basis combined with the fact that in the best of times we still run a deficit, is extremely telling. Give them $1m and they spend $2m. Give them $2m and they spend $3m. Ask them to cut back to what is given and get called a “racist” or a “tea party nut” or both.

To some of us it’s so obvious that today’s US Citizen carries more debt, less savings and more self-righteousness than any generation before them. We have paid dearly for our arrogance and will continue to pay because of ignorance.

“The problem with socialism is that you eventually run out of other people’s money. ”
— Margaret Thatcher

Good stuff Greg. How ironic that the so called ‘Capitalistic’ stance that America adhers to is now anything but. True capitalism would let the failed banks do just that. Out of the ashes can investment, growth and productivity rise in a healthy and vibrant state.

Glenn,
I agree and if we did that back in 2008 we would be on our way out of this mess by now. If the debts are not cleared and only transferred to the public, it just makes the problem far worse. I have written about this several months ago. Not only would receivership for the big banks been the right financial decision but it would have been far cheaper. We only had to cover $5 trillion or so in deposits. How much did the Fed spend, $12.3 trillion? We are still printing money in QE2 at a rate of $75 billion+ a month!!! It is still not over by a long shot!!!!! Thanks for the comment and support.
Greg

The states and fed have to tighten their belt, just like us private citizens have had to do. States must learn to live within their means, just as families do.Increasing taxes simply makes things worse. Those on state payrolls have to take the hit, along with the many, many programs that are force-funded by us broke citizens.
As a country, we have to realize that we cannot afford to continue acting like an empire. The military- industrial base must be dismanteled.Troops must be called home,overseas bases must be closed. Intervention and meddling must seize.Draconian cuts must take place across the board.
I am very doubtfull that the federal government has the where withall to take any of these actions. The system will eventually collapse under it’s own weight while the elected and appointed officials gaze upon the wreckage with the “deer in the headlights” look.
Unfortunately, it’s going to take alot of pain to convince the politicians that they don’t live in Xanadu.

States could use their formidable resources to create local currencies that actually have value. But I believe that unless states CHANGE their philosophy and their focus, which has been on corporations and those with vast amounts of money, they won’t change in necessary ways- like putting their focus on what is best for citizens and state businesses and NOT on what Wall Street or the Federal Govt wants. My hope is that at least this financial crisis will put the state/local governments attention BACK on the ones they REALLY need, their citizens, and relegate all other outside interests to the outside where they belong. If they take this opportunity to do so, the turnaround can be genuine. If not, there will probably be no turnaround at all.

Margaret,
Yes you are correct, or we could go back to some sort of gold standard. If we had that still in place this problem would have never gotten out of control. The Founding Fathers new what fiat money could do to a country. FYI, several state have legislation pending that will allow states to accept gold as payment. I find that very interesting. Thank you for the comment.
Greg

So, why did the government even bother printing money to save the banks in the first place? Why didn’t they just change the accounting rules from the beginning and allow the banks to continue along in a state of strange fantasy?

Because you’ve just said that the massive printing did not absolve a lot of their debts. So, what did it do?

Nm,
It bought some time. The problem is so big that $12.3 trillion did not cover the massive debt exposure. There is still hundreds of $trillions of OTC Derivative risk out there. Thank you for all your support and comments.
Greg

Y is NO one talking about NAFTA and want it has done to the
private sector of this great country .They have outsource every
job in America in the private sector, Why don`t we outsource the
White House . answer for every job lost in the private sector,
five federal job`s go

I worked for a large city utility dept.in CA. When I retired in 2009, I was replaced with, 3 managers at 100K and 1 supervisor and 2 workers.At this same time, they were giving employees furlough days off ! I did that job alone for 14 years. There doesn’t seem to be much oversight, and unions appear to be in the same bed with management. Government employees wages are excessive at the top, out of control.I never understood why the guy digging the ditch, got paid
less than the guy telling him to go dig the ditch…just always seemed wrong.

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Greg is the producer and creator of Greg Hunter’s USAWatchdog.com. The site’s slogan is “analyzing the news to give you a clear picture of what’s really going on.” The site will keep an eye on the government, your financial interests and cut through the media spin.

USAWatchdog.com is neither Democrat nor Republican, Liberal or Conservative. Before creating and producing the site, Greg spent nearly 9 years as a network and investigative correspondent. He worked for ABC News and Good Morning America for nearly 6 years. Most recently, Greg worked for CNN for shows such as Paula Zahn Now, American Morning and various CNN business shows.